23rd January 2017

Now the show really begins

FTSE 100
7,198, -10
11,630, +33
S&P 500
2,271, +8
iTraxx Main
69bp, unchanged
iTraxx X-Over Index
285bp, -1bp
10 Yr Bund
0.42%, +4bp
iBoxx Corp IG
B+134bp, -1bp 
iBoxx Corp HY Index
B+380bp, -5bp
10 Yr US T-Bond
2.47%, +1bp

‘America First’ has consequences far afield…

It is quite incredible that just three weeks in to the new year, we are asking “what next?”! The bond markets are telling us “growth, inflation – it’s the economy, stupid”, equities are the similarly expectant although at times a little more apprehensive as to macro/geopolitical and other event risks, while fixed income market investors are fretting about performance!

After all, 2.47%, 0.42% and 1.42% for 10-year Treasury, Bund and Gilt yields respectively, has a few in credit feeling a little uneasy – perhaps hedging with bond futures after years of not really needing to.

Nor does it help fixed income markets that the ECB’s latest forecast suggests that growth and inflation will exceed previous expectations for 2017. That is going to become a bit of a sideshow, though, to the real theatre which is now expected to emerge from the US political scene.

Trump’s policy of putting America first is potentially going to have long-term consequences for other governments. Economically, there might be considerable budgetary pressures. and NATO countries will possibly find that their defence budgets take on some more of the fiscal spending burden. At a time when many are still practising fiscal austerity, it’s most unwelcome – and means more cuts or higher spending/borrowing.

More government debt will translate into higher bond yields. Those higher yields are going to eat into returns. We will go back to the drawing board at the end of the quarter.

And it’s already showing in corporate bonds…

In a “push me, pull you”-like tradeoff, spreads are going tighter – but returns lower. The Markit iBoxx IG corporate bond index shows that spreads are a basis point tighter this year so far, having moved in a +/-2bp-like range through the opening two weeks.

However, returns have taken a knock, and fell further YTD after a weak session for government bonds on Friday last. They’re showing that IG corporate credit is returning -0.6% and we would think that it is unlikely that the next week will salvage anything for this market, leaving the year to start off in the red.

Improvements in the growth outlook are feeding through into the high yield market and with the front end of the rates curve offering support (more anchored), spreads are now 33bp tighter already this year – having gained 5bp of performance on Friday, while returns are up at +0.7%.

Overall, we think it’s going to take a steely resolve to get through these next few weeks before we can get a sense of the durability of macro’s current uptick; expectations are high that we going to get some decent growth. We will settle at some stage, before some start to fret again as we get into the French election season in the second quarter.

Primary… why not?

It’s not likely going to be a particularly defensive open this week – and even if it is, we don’t see much reason why the primary market can’t flourish. After all, if borrowers (and markets) are expecting higher yields, then now is the time to get some “cheaper” issuance away before the all-in cost rises. As we have suggested above, spreads are holding firm or edging tighter in IG and the rise in the underlying is trumping that tightening trend (yields going higher more, that is).

Admittedly, it’s about saving a few basis points here and there – but borrowers and syndicates like that machismo.

We drew a couple of blank sessions into the end of last week, but it was still a good one with Fresenius issuing €2.6bn in a 4-tranche deal leaving an IG non-financial market to deliver €4.7bn of deal flow from 5 borrowers. The total for the month so far comes in at a fairly decent €19.5bn against our initial expectations for the full-month of around €25bn. With a week to go, that level is achievable unless we get a couple of severe risk-off sessions.

The HY market, in secondary, is having a good time of it and we believe that this ought to translate into higher levels of supply. 2016 was hit-and-miss on the supply front amid many periods where the window was closed, affected by risk-off dynamics.

For now, with the growth outlook getting the benefit of the doubt, the equity markets upbeat and single name event risk absent, the stars are well aligned for borrowers to get some cash on board. The total for the month thus far stands at €2,245m.

Hold on to what you’ve got

Article 50 will be triggered in any event

After the flurry of activity in primary, investors will be content to sit on their bonds amid the volatility in equities, government bonds and anything in secondary credit.

We have the Supreme Court’s Brexit ruling come Tuesday at 09:30, which might cause some very short-term kerfuffle around sterling and UK rate markets, but the government has a plan B, we’re led to understand.

Article 50 is going to be triggered.

The US earnings season steps up a gear with some of the big guns slated to report including Microsoft, McDonald’s, Intel, Ford, Yahoo, Verizon and Caterpillar. US and UK GDP numbers for Q4 are also due at the end of the week.

Trump has promised he will get down to it immediately and having repealed much of Obamacare already, he has been true to his word. It’s showtime in the US.

Have a good day.

Suki Mann

A 30+ year veteran of the European corporate bond markets and in his role as Credit Strategist, Dr Mann has been ranked number one in the Euromoney Investor Survey eight times in ten years. Previously with Societe Generale and UBS, he now shares views of events in the corporate bond market exclusively here on CreditMarketDaily.com.